The evolution of the bank run — Part II by Claudio Grass
No economy is immune to public panic
The risk of a bank run is also present in much more stable economies and a harsh crisis is not necessary to trigger it. A prime and fairly recent example of this can be found in the mass withdrawals Home Capital faced in 2017, in Canada. The lender, based in Toronto, offered uninsured mortgages to borrowers who had been rejected by traditional banks and it came under fire by Ontario Securities Commission that accused the company of violating securities laws and misleading shareholders. As a result of the accusations, Home Capital faced a run on deposits and saw its share price collapse, by over 70%. According to Reuters, “investors withdrew more than 90 percent of funds from the mortgage lender’s high-interest savings accounts.” In order to stay afloat, the company had to secure emergency credit lines with exorbitant interest rates and to sell off large parts of its business. Earnings took a serious hit, compounding the damage that was inflicted on investors by the collapse of the stock price.
A similar scenario unfolded in May 2019 in the UK. This time the target was Metro Bank, a lender that’s been mired in controversy since the beginning of the year, after the revelation of a £1.7 billion ($2.2 billion) accounting error that seriously understated the risk levels of its loans. As a result, the bank’s shares took a nosedive of nearly 40% and faced great challenges in raising fresh funds. In the weeks that followed, there were considerable deposit outflows from large business customers. However, the bank run started in earnest with a rumor that originated in a popular messaging app and quickly spread through social media. The fear of the bank’s imminent collapse, although unsubstantiated, drove hundreds of customers to form long queues at many of the bank’s branches to withdraw their deposits. Interestingly, according to reporting by the Guardian, “the majority of customers queuing were primarily interested in accessing items stored in safety deposit boxes rather than cash in their accounts”, such as jewelry and gold.
The modern bank run and its far-reaching implications
The observant reader will be quick to identify the common thread in all these cases. Unlike the bombastic bank collapses of the past century, today’s bank runs do not usually result in the same type of losses for the bank customer as they used to. Mechanisms have been established to provide emergency liquidity and various regulations have helped shore up public confidence in banks.
In most developed nations, bank deposits, up to a certain amount, are insured, which goes some way into assuaging the public’s fears in the event of a financial meltdown, thereby making bank runs a less explosive affair. What’s more, the actual consequences of a bank facing insolvency are very different today. Governments are much more eager to step in and depositors are much less likely to simply lose everything. This might sound like we’re much safer now than ever before, yet when one thinks about it for a moment and carefully considers many of the cases we looked at above, the real risk quickly becomes apparent.
Due to this relatively new trend of swift and decisive government intervention, it is true that the customers of a single distressed bank are unlikely to lose everything, but bail outs and liquidity injections of taxpayer money mean that their losses are covered by everyone else. What is even more ominous is that the extensive powers that governments have bestowed upon themselves over the banking sector might give them the ability to support and stop lenders from collapsing, but they also give them access to their customers deposits. As we saw in the case of Cyprus, this power can be used to simply take what they need to pay their bills.
As faith in financial institutions and in the banking sector wanes, especially since the 2008 crisis, the system’s defense against possible bank runs has been significantly bolstered. The approach now is proactive and the threat of a bank run can be squashed, most of the time, by closing the banks and by imposing capital controls. So far, even though it deeply damages the banks’ credibility and undermines public trust, this response has been effective in the short term in preventing flash crashes. Of course, for the “receiving end” of these measures, the consequences have varied greatly, from mere inconvenience to existential threat. Capital controls have placed countless bank customers, cash-reliant pensioners and entire households in impossible positions. As access to their accounts was severely limited, many struggled to meet their financial obligations, to pay their bills or cover emergency expenses. For businesses it was even worse. Unable to withdraw or to transfer abroad the amounts needed for daily operations without special permission for the government, numerous business owners faced serious difficulties in paying their suppliers and employees on time. Then they, in turn, struggled to pay for their own daily needs and to make ends meet, thereby creating a vicious cycle of illiquidity. In more ways than one, these limitations on the free flow of money effectively pass on the liquidity crunch from the bank to the wider economy.
However, all these mechanisms heavily rely on depositors trusting the banking system. Despite the newly extended government powers and despite the normalization of once unthinkable practices such as the “bail-in”, responsible savers and investors still have the option to “opt out”, by storing at least part of their assets in a safe jurisdiction and outside the banking system. Physical precious metals offer the best possible protection in this regard, as they not only serve as a solid insurance against the banking sector’s vulnerabilities, but also offer a strong defense against the monetary and inflation risks, that usually accompany aggressive interventionism.
Claudio Grass, Hünenberg See, Switzerland
www.claudiograss.ch
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